Back in the black: Making investing in European banks worthwhile again

May 08, 2018

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by Colin Brereton EMEA Financial Services Markets Solutions Leader

Email +44 (0) 20 7213 3723

With cost income ratios above 60%[1] and return on equity (RoE) still failing to cover the cost of capital, attracting investment in European banks is a tough ask.

Following ten years of deleveraging and recapitalisation, solvency is no longer in jeopardy. Yet the commercial and operational position of many, if not most, European banks is unsustainable. It may even be systemically hazardous – in any other industry, the survival of so many businesses delivering an economic loss year in year out would be in doubt. The contrast with US banks is stark, not just in RoE now, but progress with the digital transformation that’s crucial to sustaining customer loyalty and driving shareholder rewards in the years ahead.

The drags on returns are all too familiar – capital and compliance demands, low interest rates, an overbanked marketplace, antiquated legacy systems and  high, but slowly falling, non-core and non-performing assets.

Are banks moving far and fast enough to get out of this hole? When we asked the some 450 industry professional attending PwC’s European Bank Restructuring Conference how they expect banks to address market, regulatory and technological pressures over the next 12 months, the significant majority of respondents,  45%, said  “respond to ad hoc challenges in incoherent ways with limited or no commercial effect”. Only 17% voted for “reform their strategies and operating models and become more profitable”.

 

Bank-reactionSource: Survey of participants at PwC’s European Bank Restructuring Conference 2018

Decisions kicked down the road

European banks’ recent record would tend to bear out this pessimistic outlook. The consolidation of fragmented markets still has a long way to go. Digital transformation could not only reduce costs, but also boost income by enabling banks to differentiate their offerings and target and tailor products more precisely. Yet, despite significant spending on technology, the actual returns from robotic process automation (RPA) and other systems investments have so far been disappointing. The deadweight of older legacy systems and overly extensive branch networks is highlighted by the fact that the cost-income ratio of many online banks is less than half of their conventional counterparts.

Turning point

Despite these negatives the panel discussion I chaired pointed to a more favourable environment. The European economy is rebounding, although this won’t be enough to float every boat in the water.

Banks are also benefiting from a more settled regulatory landscape and greater acceptance by the European Central Bank for consolidation together with rigorous attention to tackling the non performing exposures overhang. Looking ahead, there appears to be growing recognition among some regulators that further capital demands need to be balanced to enable capacity for investment in service improvement and growth.

The banks that are set to survive and thrive are using these positive developments as the cue to take some of the tough decisions that have been put off for too long. “Banks can’t control base rates, but they can control their cost base. Product simplification, clearing away legacies and investing intelligently in technology are the keys,” said a panellist. Making digital investment pay in a way that it hasn’t so far would include clear identification and focus on the ‘pain points’ and market openings that emerging technologies can address. Replacing legacy systems without breaks in service can of course be difficult. Potential solutions include creating fully modernised capabilities in one go such as a digital bank. Once the capabilities are developed, tested and refined, the clients using previous systems can be moved over to the new platforms.

   Important-issuesSource: Survey of participants at PwC’s European Bank Restructuring Conference 2018

Further priorities include discarding the cushion of government support, implicit and explicit, as banks look to accelerate innovation and put lending on a more economic footing. Aviation offers a telling example of an industry that has emerged stronger from the unwinding of government support. Developments such as open banking could provide banking with a catalyst for restructuring and innovation in the same way as budget airlines forced a strategic rethink among national carriers. The UK’s withdrawal from the EU could initially heighten the cost challenges by requiring restructuring on either side of the Channel, though it could also provide a catalyst for fresh strategic thinking and operational approaches.

Deal drivers

M&A is set to play a critical role in putting European banks back in the black, both through accelerated consolidation and in acquiring the talent and technology needed to reinvigorate growth.

While scale and synergies will continue to be important, effective deal strategies and targeting should also focus on where the business wants to be and how it’s going to get there as digital transformation and shifts in customer demand continue to gather pace. What growth opportunities are these developments opening up, how are banks placed to capitalise, and what gaps in the necessary capabilities and market access would be bridged by acquisitions? How could acquisitions provide rapid and game-changing boosts to productivity which are needed to deliver sustainable returns?

Delivering deal value in this fast-changing marketplace is likely to require earlier identification of the specific value drivers (the why) and how to deliver them (the how). With support from new analytical techniques, these evaluations would form the basis for clear and actionable strategies for realising this value potential from targeting through to integration and maximising post-deal returns.

Boosting returns

So, while investors are getting impatient, the opportunities to boost returns are rising. M&A offers a relatively quick and effective way to deliver the necessary transformation of operational efficiency and commercial capabilities. The options of doing nothing or responding reactively are not viable.

© 2018 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. This content includes some of the themes discussed during the European Bank Restructuring conference and hence views expressed here are not necessarily those of PwC. It also includes findings from live polling which gave participants the opportunity to convey their views on the direction of the market”

 

[1] European Banking Authority Dashboard

 

by Colin Brereton EMEA Financial Services Markets Solutions Leader

Email +44 (0) 20 7213 3723